In 1982 Time magazine declared the computer 'person of the year'. As for so many people and firms feted on the front cover of magazines, this proved to be a curse: computers failed to live up their billing. In 1987, Robert Solow, a Nobel laureate in economics, famously said:

'You can see the computer age everywhere but in the productivity statistics.'

This is an important question. Productivity growth is the single most important economic indicator. It determines how fast living standards can grow. The reason why the average American today is seven times better off than his counterpart at the turn of the century is that he is seven times as productive. Faster growth not only lifts living standards, it also boosts tax revenues and makes it easier to pay for tomorrow's pensions.
So why has it taken so long for that investment to show up in faster productivity growth? The history of previous productivity advances indicates that there were also long lags before both steam power and electricity boosted productivity. Work by Paul David, an economist at Oxford University, shows that productivity growth did not accelerate until 40 years after the introduction of electric power in the early 1880s. This was partly because it took until 1920 for at least half of American industrial machinery to be powered by electricity. But firms also needed time to figure out how to reorganise their factories around electric power to reap the efficiency gains.

Paul David suggests that a technology will start having a significant effect on productivity only when it has reached a 50% penetration rate. American computer use has reached the 50% mark only recently, and other rich economies still lag behind. That puts IT at roughly the same stage now that electricity had reached in 1920. Almost exactly on cue, growth in labour productivity in America's business sector has increased to an annual average of 2.9% since 1996, from an average of 1.4% in 1975-95 (see chart).

In the year to the second quarter of 2000, productivity surged by 5.2%.
There are two different measures of productivity. Labour productivity (output per man-hour), and total factor productivity (TFP), which takes account of the efficiency with which both capital and labour inputs are used. That is a measure of how productive both labour AND capital have been.

To most people, it is labour productivity that matters, because this is what ultimately determines living standards. Economists, though, get more excited about TFP growth, which they see as a costless way of boosting growth without increasing scarce inputs. Faster TFP growth automatically increases labour-productivity growth. Nobody doubts that productivity in the sector that produces IT goods has surged, with growth in the 1990s averaging 24% a year. The disagreement is about the effect of IT on the rest of the economy.

A study by Stephen Oliner and Daniel Sichel at the Federal Reserve in Washington concluded that IT has been the key factor behind America's improved productivity growth. They estimated that over half of the acceleration in US productivity growth between the first and second halves of the 1990s was due to faster TFP growth, of which three-fifths came from efficiency gains in computer usage.

But as we all know, ask two economists the same question and you'll get three answers. Consequently there are dissenting voices. Indeed, the sectors that have invested most in IT have generally seen smaller productivity gains. This could be due to measurement problems, but for the moment it casts some doubt on the argument that IT is boosting TFP growth throughout the economy willy-nilly.
Robert Gordon, an economist at Northwestern University and one of the most outspoken new-economy sceptics is less impressed by America's productivity 'miracle' than other economists. He reckons that the entire increase in total factor productivity outside the computer sector is due to the economic cycle.

At times of rapid growth, firms work employees harder, so productivity rises; but then it falls again in the next downturn. Moreover, he finds that after excluding the manufacture of all durable goods as well as of computers, there has been absolutely no increase in labour productivity in the remaining 88% of the economy, after adjusting for the cycle. Yet this is where most of the investment in computers has taken place. He concludes that the productivity paradox is alive and well.

Robert Gordon is not surprised that IT has failed to lift TFP growth throughout the economy. Computers and the Internet, he says, do not rate as an 'industrial revolution', as did electricity and the car. Much Internet activity, he argues, is merely a substitute for things that are already being done. For example, downloading music simply replaces buying a CD; it does not create new products, in the way that electricity prompted the invention of the vacuum cleaner and the fridge. Indeed, the Internet can even reduce productivity in the workplace. The traffic on many consumer-oriented websites, he notes, peaks in the middle of the working day, not in the evening!

The evidence from overall economic data may be mixed, but studies that look at individual firms suggest that computers have yielded substantial gains. In an analysis of 600 big American firms between 1987 and 1994, Erik Brynjolfsson at MIT and Lorin Hitt at the University of Pennsylvania found that investment in computers appeared to boost annual TFP growth by 0.25-0.5%.
The productivity gains got bigger over longer periods, confirming that it takes time for firms to reorganise their business before they reap the full benefits of IT. Their research also shows that firms that coupled IT investment with changes in the work was organised enjoyed the biggest productivity gains from IT.